Faced with growing fiscal challenges and the specter of increasingly trigger-happy credit rating agencies, the new center-right Spanish government has acted to temporarily put a halt to awarding new feed-in tariff (FIT) contracts starting in January 2013. The move is expected to have immediate impacts on approximately 4,500 MW of wind power projects, 550MW of solar PV projects, as well as a number of projects in other technology classes.

The change was passed as part of Royal Decree-Law (RDL 1/2012) in January 2012 and it will prevent proponents of new cogeneration, renewable energy and waste-to-energy plants from receiving contracts to sell their electricity to the grid, effectively putting the domestic RE industry on hold while the government drafts a new strategy for the electricity sector.

As expected, this move has triggered a storm of debate from many within the renewable energy industry, who argue that Spain is further undermining its credibility as a stable country in which to invest. The Spanish Renewables Foundation, a leading advocacy group, has warned that the move risks wiping out hundreds of thousands of direct and indirect jobs, along with tens of billions in existing and future investments.

The main driver behind this decision is addressing the country’s electricity system deficit, which stands at over €24 Billion. Compounding the problem is that electricity demand in peninsular Spain has been declining since the global financial crisis of 2008, resulting in significant excess generation capacity.

While the current changes are in many ways less dramatic than the retroactive changes put forward in 2010, there is no question that they have added yet another complex plot twist to this ongoing saga, and re-galvanized the debate around the future of renewable energy in Spain. (For a look at previous changes to the Spanish electricity market, see this earlier Brief.)

This analysis takes a closer look at the situation occurring in Spain, with a focus on the challenges facing its electricity system and the solutions being proposed to address them.

Where does the electricity system deficit come from?

For over a decade, the Spanish government has prevented utilities from charging consumers the true costs of electricity. In other words, the final price paid by both large and small electricity buyers has been kept artificially low, in an arguably misguided attempt to contain inflation, protect consumers, and maintain the competitiveness of Spanish industry.

This put the entire Spanish electricity system on a collision course with economic reality, and made a growing tariff deficit all-but-inevitable.

This can be seen by looking at the trajectory of electricity prices that took place after Spain began liberalizing — or deregulating, in American parlance — its electricity market in 1997.

Ironically, the liberalization of the electricity market (i.e. allowing generators to compete with one another) led to a greater political desire to control electricity rates, allegedly to protect consumers from unpredictable market gyrations.

In response, the government created a mechanism akin to a deferral account that allowed utilities to recover shortfalls in any individual year from revenues generated in subsequent years.

This created a deficit, or shortfall, in utilities’ financial statements which, taken collectively, generated a growing electricity system deficit.

The government had always planned to recover this shortfall from within the electricity system itself — what was never clearly articulated by Spanish officials was how that would take place.

Viva la liberalización

The process of liberalization of the electricity market in Spain, like in many other areas of the world, aimed to move certain components of the electricity system (namely, generation and marketing) toward competition, while other aspects would remain regulated, such as transmission, and distribution.

It is important to note that the majority of wind power (in contrast to solar for instance) transacted in Spain (~95%) is sold directly on the spot market; and instead of increasing costs to ratepayers, the roughly 40 TWh of wind power sold every year on the open market have actually helped lower spot market prices.

The size of these cost savings were calculated at approximately 0.5 cents/kWh in 2009, saving Spanish ratepayers €766 Million according to CNE, the national energy regulator.

Renewable Energy: Onward and Upward

Renewable energy only began entering the Spanish electricity market in a significant way after 1998 with the growth in the wind industry, while other renewables like solar photovoltaics (solar PV) only began to be developed in earnest after Spain’s 2004 reforms. For biomass and biogas technologies, it took the 2007 reforms to generate any interest.

Building on this picture, the subsequent graph shows how this capacity translates into actual electricity generation, and how it relates to the total generation of the electricity system (TWh).

The following graph shows a projection of the share of each renewable energy source as a percentage of total generation for 2013, alongside the total premium payments that will be received by that technology in that year. This shows that while wind power will remain the largest source of RE generation (65%), it will represent less than a third of total premiums paid (30%). In contrast, both solar PV and concentrating solar power (CSP) have a larger proportional share of the total RE payments.

El Deficit

The root cause of the electricity system deficit, and in turn of the suspension, is that revenues from electricity sales are insufficient to pay for the cost of the electricity system.

In order to cover this gap, utilities in Spain started auctioning off the debt; however, in 2009, the Spanish government was forced to step in and provide sovereign backing for this debt. Predictably, this has generated two further problems for the government: first, assuming responsibility for the deficit effectively increases its net debt; and second, these debt auctions directly compete with Spain’s own bond issuance.

Of Deficits and Downgrades

Compared to many of its European compatriots such as Italy and Greece, which have debt-to-GDP ratios of over 120%, Spain’s ratio has only recently surpassed 60%. And despite the considerable size of the electricity system deficit, it only represents 3% of Spain’s GDP.

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Toby Couture is Founder and Director of E3 Analytics, a leading energy consultancy based in Berlin. He works on a wide range of topics in renewable energy, including policy and regulatory support, energy strategy, market research, and economic...